AASB 16 Leases replaces all existing leases requirements (AASB 117 Leases, Interpretation 4 Determining whether an Arrangement contains a Lease and related Interpretations). For lessees, the distinction between operating and finance leases will no longer exist. Instead, AASB 16 will require lessees to account for practically all leases using a single on-balance sheet model in a similar way to finance leases pursuant to AASB 117.

The standard includes two recognition exemptions for lessees: leases of ’low-value’ assets and short-term leases (i.e., leases with a lease term of 12 months or less). At the commencement date of a lease, a lessee will recognise a liability representing its obligation to make future lease payments (i.e., the lease liability) and an asset representing its right to use the underlying asset for the lease term (i.e., the right-of-use (ROU) asset). Lessees will be required to separately recognise interest expense on the lease liability and depreciation expense on the ROU asset rather than operating lease expense.

The lease expense recognition pattern for lessees will generally be accelerated as compared to today. Key balance sheet metrics such as gearing and finance ratios, debt covenants and income statement of profit or loss metrics, such as earnings before interest, taxes, depreciation and amortisation (EBITDA), will be impacted. Also, statement of cash flows for lessees will be affected as payments for the principal portion of the lease liability will be presented within financing activities.

Lessor accounting is substantially unchanged from existing accounting pursuant to AASB 117. Lessors will continue to classify all leases using the same classification principle as in AASB 117 and distinguish between two types of leases: operating and finance leases.

The standard will require lessees and lessors to make more extensive disclosures than required by AASB 117.

Overview of assessment activities

In the first half of FY18, the leases project team continued its review of the in-scope operating lease contracts, to identify the key terms required to calculate the lease liabilities and related ROU assets, and to identify key decisions made pursuant to the existing lease arrangements which may affect the lease calculation. Key assumptions were determined and documented and then reviewed by internal stakeholders.

Subsequent to this, the team calculated the financial impact of adoption of the new standard pursuant to both adoption methodologies. The financial impact was communicated to management, the Audit & Risk Management Committee and AGL’s auditors.

An accounting policy supporting the adoption of the new standard has been approved and the impact of adoption of this standard included in AGL’s forecast financial performance. Some of the key issues identified include: application of the grandfathering provision; determination of what constitutes a low-value asset; determination of the incremental borrowing rates; and assessment of what constitutes reasonably certain for the purposes of assessing whether an option to extend, or to terminate, a lease contract will be exercised.

Application date and transition approach

AASB 16 is effective for annual reporting periods commencing on or after 1 January 2019, with early application permitted for entities that apply AASB 15. AGL has elected to early apply AASB 16, which means it will be effective for AGL’s 30 June 2019 financial statements. The standard permits two methods of adoption: full retrospective or modified retrospective. AGL has elected to apply the full retrospective method which will result in an adjustment to each prior reporting period presented and recognition of the cumulative effect of initially applying the new requirements at the start of the earliest period presented, which will be 1 July 2017.

The grandfathering provision pursuant to AASB 16 will be applied at the date of initial application.

Impact on AGL’s financial report

The adoption will result in a restated cumulative retained earnings decrease of $4 million, a restated decrease in profit for the year ended 30 June 2018 of $1 million, a restated increase in property, plant and equipment of $74 million, a restated increase in deferred tax assets of $2 million, a restated decrease in non-current other liabilities of $40 million, a restated increase in current borrowings of $16 million and a restated increase in non-current borrowings of $105 million.

More specifically, the impact to the Consolidated Statement of Profit or Loss will result in a restated increase in depreciation and amortisation of $11 million, restated increase in finance costs of $7 million and a restated decrease in total expenses of $16 million for the year ended 30 June 2018. As a result of the above, tax expense for the year ended 30 June 2018 will decrease by $1 million.

For the year ending 30 June 2019, adoption of AASB 16 is expected to result in an increase in depreciation and amortisation of $12 million, an increase in finance costs of $7 million and a decrease in total expenses of $18 million. As a result of the above, tax expense for the year ending 30 June 2019 is expected to decrease by $1 million.

AGL’s existing finance leases (see Note 20) will not be materially impacted by the new standard. The relevant finance lease assets will be presented as ROU assets pursuant to the new standard.